For investors, pot industry mix of potential, risks

Tim Loh

Published 9:27 pm, Friday, July 19, 2013

Brendan Kennedy, looking Wall Street-savvy in his dark suit and thick blue tie, stared into a camera on CNBC's "Squawk Box" one morning this spring, patiently recounting how he plans to profit from pot. Across the table -- and across a societal divide Kennedy hopes to transcend, it seemed -- the host squinted, turned his head and looked utterly perplexed.

"I listened to what you're going to do," said CNBC's Joe Kernan. "What businesses are you talking about?"

"We have a private equity fund that has raised capital from investors across the country," Kennedy replied. "And our focus is on elevating the conversation and creating mainstream brands that are different than the typical cliches you see in the market."

In fact, Kennedy's fund -- Privateer Holdings -- is part of a growing stable of businesses trying to nudge forward and capitalize on this country's growing tolerance for marijuana. The firm just raised $7 million from investors that include ranchers in Texas, farmers in Kansas and finance professionals in New York, it announced last week. Kennedy and his business partner Michael Blue -- former classmates at the Yale School of Management -- embody the increased sophistication entering the world of weed: Kennedy's worked in Silicon Valley; Blue's worked at de Visscher and Co., a small investment bank in Greenwich.

Convincing pitches

These days, people thinking of investing in the marijuana sector are hearing increasingly convincing pitches: In April, the Pew Research Center reported that 52 percent of adults favor full legalization, raising hopes for some that the federal government will one day lift its prohibition. Meanwhile, 19 states and Washington, D.C., have legalized the drug for medical purposes, while the states of Washington and Colorado last November legalized it for all adults. But because marijuana is federally banned, the investing opportunities are fraught with complications and risk -- from both legal and business standpoints.

Even so, industry experts say the sorts of people jumping in over the past year are raising eyebrows.

"There are people who own yachts in Cape Cod, suddenly interested in marijuana as a business and a medicine," said Justin Hartfield, the 29-year-old founder of WeedMaps.com, a 5-year-old hub of information about cannabis dispensaries that has 300,000 registered users and some 4 million monthly visitors.

Seeking $25 million

Last month, Hartfield -- excited by the number of potential investors he'd recently seen in business suits at a cannabis convention in Colorado -- launched one of the industry's first venture capital funds, Emerald Ocean Capital. He hopes to raise $10 million to $25 million to invest in firms that develop the marijuana industry without actually growing, handling or selling the drug (for legal reasons). Hartfield, based in Orange County, Calif., says he's received 450 inquiries about the fund already, but grants that many are less than serious.

"Still, there are some really, really awesome, unexpected people," he said by phone, describing a typical investment these days as exceeding $100,000 and occasionally topping $1 million, a remarkable jump over recent years.

"Even two CEOs currently active at Fortune 500 companies made inquiries," he said.

For its part, Privateer's first acquisition was Leafly.com, a Yelp of sorts for the industry that classifies the more than 540 strains of cannabis by their effects such as increased appetite, euphoria or calmed nerves. By listing where each strain can be found, the site aims to help people who may be suffering from ailments like glaucoma and HIV, or undergoing chemotherapy, to treat their symptoms, the company says.

Next up for Privateer: an online cannabis news site and an online store offering "Office Depot-style one-stop shopping" for supplies needed by dispensaries, the firm says.

Penny stocks

A second tier of investment in the pot industry involves a handful of public companies, mostly penny stocks prone to the sorts of turbulence, uncertainty and risk of failure or fraud that is endemic to the sector. For example, after last November's elections, the stock price for MedBox, which provides automated cannabis dispensers, skyrocketed from $3 to over $200 in a matter of weeks before settling back down to about $23.

A third opening for investors is the ancillary companies that are proliferating to serve the industry while not taking the federally illegal step of touching marijuana. In addition to the sorts of companies that Privateer and Emerald Ocean are scouring through, there is an infrastructure of lawyers, marketers, insurers, pharmacists and other professionals taking shape.

Finally -- and perhaps riskiest of all -- investors can invest in the marijuana production and dispensary facilities themselves.

"There are lots of investors who don't want their names out there for many reasons," Walsh said of the overall market, by some estimates worth about $1.5 billion right now. "Mainly because this is an illegal drug and investors don't like to take on a lot of risk in the first place -- and that's a huge one."

Risks at all levels

Indeed, the stakes of investing can be greater than simply losing your shirt. This spring, former California dispensary owner Matt Davies was sentenced to five years in federal prison, sending shudders of concern through the industry that the federal government could more actively enforce anti-marijuana laws. So far, investors at all levels have been spared.

"It's hard to say which way the federal government is leaning, but the silence has been pretty eerie," notes Mark Kleiman, professor of public policy at UCLA who's helping the state of Washington set up its legal cannabis industry. Regarding financiers of firms that actively break federal law, Kleiman says: "It's not at all impossible that some aggressive prosecutor is going to prosecute all the stockholders."

A second risk: It's unclear how big the industry could become, or which ventures would triumph, if the federal prohibition is one day lifted.

"Some people say $50-to-$60 billion, but we don't subscribe to that," said Walsh. "But once it is legalized, it is going to be harder to make a buck than it is on the black market. But even as profits go down, as in any industry, you will have plenty of people making money and succeeding."

Bigger than wine industry

Hartfield guesses the industry would be in the $35 billion to $40 billion range -- a little bigger than the U.S. wine industry, he said, and he hopes of a comparable nature if the right regulations get set up.

Kleiman, however, casts a more skeptical glance. He already sees a "dot-com" frenzy taking place, with too much money chasing an industry that, even if legal, would have limited earning potential. Meanwhile, he fears investors could get fleeced by unscrupulous businesses or find themselves prosecuted if they step the wrong way in the short term. The lifting of prohibition, he maintains, would lay bare the fact that there isn't as much money to be made as people think.

"If Privateer Holdings does what they say they're going to do, they probably aren't at any substantial legal risk," he says. "And if their managers are very clever and know how to invest in Amazon.com rather than Pets.com, maybe they'll be able to return some money to their investors."